PART 3: STRATEGIC ACTIONS: STRATEGY IMPLEMENTATION CHAPTER 10 CORPORATE GOVERNANCE Authored by: Marta Szabo White, PhD Georgia State University THE STRATEGIC MANAGEMENT PROCESS ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use KNOWLEDGE OBJECTIVES ● Define corporate governance and explain why it is used to monitor and control top-level managers’ decisions ● Explain why ownership is largely separated from managerial control in organizations ● Define an agency relationship and managerial opportunism and describe their strategic implications ● Explain the use of three internal governance mechanisms to monitor and control managers’ decisions ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use KNOWLEDGE OBJECTIVES ● Discuss the types of compensation top-level managers receive and their effects on managerial decisions ● Describe how the external corporate governance mechanism— the market for corporate control—restrains top-level managers’ decisions ● Discuss the nature and use of corporate governance in international settings, especially in Germany, Japan, and China ● Describe how corporate governance fosters the making of ethical decisions by a firm’s top-level managers ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use OPENING CASE CORPORATE GOVERANCE: WHAT IS ALL THE FUSS ABOUT? ■ Corporate governance can destroy or create value for a firm ■ It is concerned with: strengthening the effectiveness of a company’s board of directors verifying the transparency of a firm’s operations enhancing accountability to shareholders incentivizing executives maximizing value-creation for stakeholders and shareholders ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use OPENING CASE CORPORATE GOVERANCE: WHAT IS ALL THE FUSS ABOUT? ■ Given recent criticisms, boards’ actions in nations throughout the world are being more carefully scrutinized and regulated ■ In the U.S., that after being fired by their firm, a number of CEOs still remain as members of other firms’ boards of directors, is drawing close attention ■ Corporate governance is weak in many Chinese firms and there is concern about the validity and reliability of some auditors’ work and the quality of companies’ financial statements ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use OPENING CASE CORPORATE GOVERANCE: WHAT IS ALL THE FUSS ABOUT? ■ The reason there is a “fuss” about corporate governance is that these activities are critical to globally signaling transparency coupled with strategic competitiveness ■ Corporate governance fundamentals: Corporate Directors should: ● Focus on creating long-term value for shareholders ● Use performance-related pay to attract and retain senior management ● Exercise sound business judgment to evaluate opportunities and manage risk ● Communicate with key shareholders ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use CORPORATE GOVERNANCE Corporate governance: a set of mechanisms used to manage the relationships (and conflicting interests) among stakeholders, and to determine and control the strategic direction and performance of organizations (aligning strategic decisions with company values) • When CEOs are motivated to act in the best interests of the firm—particularly, the shareholders—the company’s value should increase • Successfully dealing with this challenge is important, as evidence suggests that corporate governance is critical to firms’ success ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use CORPORATE GOVERNANCE Corporate Governance Emphasis Two reasons: • Apparent failure of corporate governance mechanisms to adequately monitor and control top-level managers’ decisions during recent times • Evidence that a well-functioning corporate governance and control system can create a competitive advantage for an individual firm ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use CORPORATE GOVERNANCE Corporate Governance Concern • Effective corporate governance is of interest to nations as it reflects societal standards: • Firms’ shareholders are treated as key stakeholders as they are the company’s legal owners • Effective governance can lead to competitive advantage • How nations choose to govern their corporations affects firms’ investment decisions; firms seek to invest in nations with national governance standards that are acceptable ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Germany • Banks exercise significant power as a source of financing for firms • Two-tiered board structures, required for larger employers (more than 2,000 employees), place responsibility for monitoring and controlling managerial decisions and actions with separate groups • Power sharing includes representation from the community as well as unions ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Germany Germany: Two-tiered Board The management board is responsible for all Vorstand the functions of strategy and management Responsible for appointing members to the Aufsichtsrat Employees Union Members Shareholders Vorstand Responsible for appointing members to the Aufsichtsrat ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Germany ● Proponents of the German structure suggest that it helps prevent corporate wrongdoing and rash decisions by “dictatorial CEOs” ● Critics maintain that it slows decision making and often ties a CEO’s hands ● The corporate governance practices in Germany make it difficult to restructure companies as quickly as in the U.S ● Banks are powerful; private shareholders rarely have major ownership positions in German firms ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Germany ● Large institutional investors, e.g., pension funds and insurance companies, are also relatively insignificant owners of corporate stock ● Less emphasis on shareholder value ● This traditional system produced agency costs because of a lack of external ownership power ● Changes - German firms with listings on U.S stock exchanges have increasingly adopted executive stock option compensation as a long-term incentive pay policy ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Japan ● Cultural concepts of obligation, family, and consensus affect attitudes toward governance ● Close relationships between stakeholders and a company are manifested in cross-shareholding, and can negatively impact efficiencies ● Keiretsus: strongly interrelated groups of firms tied together by cross-shareholdings ● Banks (especially “main bank”) are highly influential with firm’s managers ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Japan ● Japan has a bank-based financial and corporate governance structure whereas the United States has a market-based financial and governance structure ● Banks play an important role in financing and monitoring large public firms ● Powerful government intervention ● Despite the counter-cultural nature of corporate takeovers, changes in corporate governance have introduced this practice ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in Japan Changes: ● Deregulation in the financial sector has reduced the cost of hostile takeovers, facilitating Japan’s previously nonexistent market for corporate control ● Diminishing role of banks monitoring and controlling managerial behavior, due to their development as economic organizations ● CEOs of both public and private companies receive similar levels of compensation, which is closely tied to observable performance goals ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in China Changes: ● Major changes over the past decade ● Privatization of business and the development and integrity of equity market ● The stock markets in China remain young and underdeveloped; in their early years, they were weak because of significant insider trading, but with stronger governance these markets have improved ● The state dominates—directly or indirectly—the strategies that most firms employ ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Corporate Governance in China ● Firms with higher state ownership have lower market value and more volatility ● The state is imposing social goals on these firms and executives are not trying to maximize shareholder wealth ● Moving toward a Western-style model ● Chinese executives are being compensated based on the firm’s financial performance ● Much work remains if the governance of Chinese companies is to meet international and Western standards ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use INTERNATIONAL CORPORATE GOVERNANCE Global Corporate Governance • Relatively uniform governance structures are evolving • These structures are moving closer to the U.S corporate governance model • Although implementation is slower, merging with U.S practices is occurring even in transitional economies ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR It is important to serve the interests of the firm’s multiple stakeholder groups! Capital Market • In the U.S., shareholders (in the capital Stakeholders market group) are the most important stakeholder group served by the Board of Directors Product Market Stakeholders • Governance mechanisms focus on control of managerial decisions to protect shareholder Organizational interests Stakeholders ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR It is important to serve the interests of the firm’s multiple stakeholder groups! Capital Market Stakeholders • Product market stakeholders (customers, suppliers, and host communities) and organizational stakeholders (managerial and non-managerial employees) are also Product Market Stakeholders important stakeholder groups and may withdraw their support of the firm if their needs are not met, at least minimally Organizational Stakeholders ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR It is important to serve the interests of the firm’s multiple stakeholder groups! Capital Market Stakeholders • Some observers believe that ethically responsible companies design and use governance mechanisms that serve all stakeholders’ interests Product Market Stakeholders • Importance of maintaining ethical behavior is seen in the examples of Enron, Arthur Andersen, WorldCom, Organizational Stakeholders HealthSouth and Tyco ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR ● For 2011, some of World Finance’s “Best Corporate Governance Awards” by country were given to: ◘ Royal Bank of Canada (Canada) ◘ Vestas Wind Systems A/S (Denmark) ◘ BSF AG (Germany) ◘ Empresas ICA (Mexico) ◘ Cisco Systems (United States) ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR ● These awards are determined by analyzing a number of corporate governance issues: ◘ Board accountability/financial disclosure ◘ Executive compensation ◘ Shareholder rights ◘ Ownership base ◘ Takeover provisions ◘ Corporate behavior ◘ Overall responsibility exhibited by firm ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use [...]... MANAGER AND SHAREHOLDER RISK AND DIVERSIFICATION FIGURE 10. 2 Manager and Shareholder Risk and Diversification ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use MANAGER AND SHAREHOLDER RISK AND DIVERSIFICATION... SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL INTRODUCTION (cont’d) • Small firms’ managers are high percentage owners, which implies less separation between ownership and management control • Family-owned businesses face two critical issues: • As they grow, they may not have access to all needed skills to manage the growing firm and maximize its returns, so may need outsiders to improve management • They... performing this function ● Costs associated with agency relationships, and effective governance mechanisms should be employed to improve managerial decision making and strategic effectiveness ● In response, U.S Congress enacted: ▪ Sarbanes-Oxley (SOX) Act in 2002 ▪ Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in mid-2 010 ©2013 Cengage Learning All Rights Reserved May not be copied,... Limited contact with the firm’s day-to-day operations and incomplete information about managers: • Results in ineffective assessments of managerial decisions and initiatives Board of Directors • Leads to an emphasis on financial, rather than strategic controls to evaluate performance of managers and business units, which could reduce R&D investments and allow top-level managers to pursue increased diversification...SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL INTRODUCTION • Historically, firms managed by founder-owners and descendants • Separation of ownership and managerial control allows each group to focus on what it does best: • Shareholders bear risk • Managers formulate and implement strategy ©2013 Cengage Learning All Rights Reserved May not be copied,... COSTS AND GOVERNANCE MECHANISMS AGENCY COSTS: the sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals, because governance mechanisms cannot guarantee total compliance by the agent ● Principals may engage in monitoring behavior to assess the activities and decisions of managers ● However, dispersed shareholding makes it difficult and inefficient... monitor management s behavior ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use AGENCY COSTS AND GOVERNANCE MECHANISMS ● Boards of Directors have a fiduciary duty to shareholders to monitor management. .. classroom use SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL FIGURE 10. 1 An Agency Relationship ©2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL AGENCY RELATIONSHIPS... represented by types of shareholders and their different incentives to monitor managers 2 Board of Directors 3 Executive Compensation The external corporate governance mechanism is: 4 Market for Corporate Control This market is a set of potential owners seeking to acquire undervalued firms and earn above-average returns on their investments by replacing ineffective top-level management teams ©2013 Cengage... Mechanisms Ownership Concentration • Relative amounts of stock owned by individual shareholders and institutional investors Board of Directors • Individuals responsible for representing the firm’s owners by monitoring top-level managers’ strategic decisions Executive Compensation • Use of salary, bonuses, and long-term incentives to align managers’ interests with shareholders’ interests External Governance ... manage the relationships (and conflicting interests) among stakeholders, and to determine and control the strategic direction and performance of organizations (aligning strategic decisions with... a passwordprotected website for classroom use MANAGER AND SHAREHOLDER RISK AND DIVERSIFICATION FIGURE 10. 2 Manager and Shareholder Risk and Diversification ©2013 Cengage Learning All Rights Reserved... Define an agency relationship and managerial opportunism and describe their strategic implications ● Explain the use of three internal governance mechanisms to monitor and control managers’ decisions